Federal Court 'Short-Circuits' Utility Plan

A federal court of appeals last week derailed energy efficiency. Specifically, the United States Court of Appeals for the District Of Columbia Circuit overturned the Federal Energy Regulatory Commission's (FERC's) Order 745, which is a federal regulation establishing rules for demand response programs.

This decision was a short-term victory for independent power producers like Exelon (EXC), NRG Energy (NRG), Calpine (CPN) and American Electric Power (AEP). It could be seen as a threat to companies like EnerNOC (ENOC), OPower (OPWR) and Comverge (private). However, it is unlikely the Court's decision will stop demand response programs.

Often called DR, demand response is a relatively new program that uses markets to reduce demand. The general idea is to provide price signals to consumers, which previously have been obscured by intermediaries.

Just about everybody agrees DR is an important idea. DR reduces the need for new power plants. It reduces the need to build new transmission lines. It lowers wholesale power prices. It also reduces regional air pollution.

DR was a threat, however, to independent power producers. It did not matter if they used solar, wind, coal, nuclear or natural gas to make their electric power, all power producers saw DR affecting their margins.

Consequently, the Electric Power Supply Association and four other energy industry associations petitioned the Court of Appeals for a review of FERC's Order 745. According to the Court, FERC's rule sought to incentivize retail customers to reduce electricity consumption when economically efficient.

Petitioners complained that FERC's new rule goes too far, encroaching on the states' exclusive jurisdiction to regulate the retail market. In a split decision, the Court agreed with petitioners and they vacated FERC's rule in its entirety.

Among other factors, DR was a significant factor behind utilities' decision to retire dozens of their power plants before their time. Approximately 70,000 megawatts of coal and nuclear plants were expected to retire only because they had become surpluses and uneconomical. DR was a major reason why those plants had become uneconomical.

With DR gone, those nuclear and coal plants may have a reprieve. For example, in PJM Interconnection's latest capacity auction, 10,974.8 megawatts of demand response cleared the auction. Those 10,975 megawatts displaced the equivalent amount of coal and nuclear plants. Considering PJM is only one of ten markets, 10,975 megawatts is a lot of potentially-recoverable capacity.

However, it is unlikely the Court's decision will be the end of DR. In all likelihood, the decision will form the framework for demand response, version 2.0. Instead of a top-town program ordered by federal regulators, the new version will likely be a bottom-up version implemented by individual state regulators.

In fact, New York State already started the process. As was described in ConEd Power Plans for Today and Future, Consolidated Edison (ED) implemented a distribution-level demand response program. As described, ConEd's approach is exactly what the Court suggested was an appropriate use of DR technology.

The legal issue is the line between federal and states' rights. It turns out that line is less than clear. Typically, wholesale electric and gas is interstate commerce, which is regulated by federal regulators. Retail electric and gas is intrastate commerce, which is regulated by state regulators.

Since it can be argued demand response is aimed as retail consumers, demand response is a retail function. As a retail function, it should be regulated by states, not federal regulators.

Not everyone agrees with the decision, including one of the appellate judges. It is not clear if the Appellate Court's decision will be appealed. If appealed, the outcome is not clear.

In the short-term, there could be confusion in the wholesale markets. Long-term, federal demand response policies will likely be replaced by state policies. In the end, DR programs could look like states' renewable portfolio standards and renewable energy programs.

Investors should not be confused. Demand response is here to stay. Ultimately, DR will displace marginal generators and the units which were to be retired will be retired. Companies offering DR services like EnerNoc, OPower and Comverge will become significant stakeholders and contributors. In fact, EnerNOC already claims the Court's decision will have only minimal impact on their revenues.